Ninth Circuit Rejects Pre-Agreed Sliding Scale Incentive Awards

Incentive awards to named plaintiffs in class action settlements are common, but prearranged incentive agreements can run afoul of ethical and procedural boundaries.

In Rodriquez v. West Publishing Corp., the Ninth Circuit recently held that prearranged incentive agreements for named class plaintiffs can create conflicts between representative plaintiffs and other class members, and between plaintiffs and their counsel. Moreover, such agreements must be disclosed at the class certification stage.

“The decision underscores the importance of complete clarity at all stages of class action of the roles of counsel and the named class representatives and what their respective interests might be vis-a-vis the class members they purport to represent,” says Loren Kieve, San Francisco, cochair of the ABA Section of Litigation Federal Practice Task Force.

The Incentive Agreements and Class Settlement Approval
Ryan Rodriquez and Reena Frailich filed a class action “on behalf of themselves and all persons who purchased a bar review course from BAR/BRI in the United States from August 1997 to the present.” They were joined by other plaintiffs from a consolidated related action. All seven were eventually designated as class representatives. The complaint alleged that BAR/BRI engaged in anticompetitive conduct in connection with bar review preparation courses.

In May 2006, the district court certified a Federal Rule of Civil Procedure Class 23(b)(3) class. The parties executed a settlement agreement in February 2007. In March 2007, the district court granted preliminary approval of the settlement. After preliminary approval, but before the final fairness hearing, class counsel filed a motion seeking incentive awards for the class representatives.

Five of the plaintiffs had entered into an incentive agreement with prior counsel that obligated class counsel to seek payment for each of them on a sliding scale. If the recovery amount was $500,000 or more, class counsel was obligated to seek a $10,000 award for each plaintiff; for $1.5 million or more, counsel would seek $25,000 per plaintiff; and for recovery of $10 million or more, counsel would seek an incentive award of $75,000 per plaintiff. The other two class representative plaintiffs were not party to any incentive agreement.

In September 2007, the district court gave final approval to the settlement but denied incentive awards to all seven class representatives. The district court found that the incentive agreements “created actual conflicts of interest in violation of public policy.” Six objectors appealed.

Disclosure of Pre-Agreed Incentive Agreement
On appeal, the Ninth Circuit found the Rodriquez incentive agreement created a conflict of interest between the representative plaintiffs and other class members.

“By tying their compensation—in advance—to a sliding scale based on the amount recovered, the incentive agreements disjoined the contingency financial interests of the contracting representatives from the class,” the Rodriquez opinion says.

The court was especially troubled that “[t]he arrangement was not disclosed when it should have been and where it was plainly relevant, at the class certification stage.”

Nonetheless, the Ninth Circuit affirmed approval of the class settlement because two nonconflicted class representatives, along with nonconflicted counsel, participated in the settlement. The court emphasized that only a single class representative untainted by the incentive agreements was necessary to adequately represent the class.

Because the Rodriquez agreement created inherent conflicts between represented plaintiffs and California law precludes attorney fees in conflicting representations, the Ninth Circuit remanded for the district court to consider the effect, “if any, of the conflict arising out of the incentive agreements on the request by class counsel for an attorney’s fee award.”

Implications for Class Action Counsel
Incentive agreements implicate “class counsel’s duty of candor to the court to disclose a critical material fact so that the Court can fairly assess the adequacy of representation of both named plaintiffs and, even potentially, class counsel as well,” notes Andrew S. Pollis, Cleveland, cochair of the Section’s Ethics and Professionalism Committee.

“Because adequacy of class representation is often a critical target for challenge at the class certification stage, there ought to be full discovery of all arrangements between named plaintiffs and class counsel to allow for fulsome analysis of the adequacy of representation,” Pollis says.

While “such incentive agreements should be subject to careful judicial scrutiny, judges should be mindful that just and reasonable incentive awards, including awards that are sometimes tied in part to the amount of any recovery, encourage class representatives to come forward and take an active role in class litigation, and therefore, fairly compensate them for their contributions to class litigation, ” says Mark Labaton, Los Angeles, a securities and class action litigator with experience serving as class counsel.